Yesterday the Greek public overwhelmingly told the ECB and specifically the Germans that they are willing to risk a complete economic collapse in an effort to receive much more favorable debt negotiation terms. Otherwise they are prepared to default on their obligations. Prior to the vote this was not viewed as a likely outcome. Yet as we know all too well expecting the unexpected in the financial markets since 2007 is a requirement, not a option.
So where do we go from here? The world equity, fixed income and currency markets are heading toward a much higher degree of volatility. The odds favor a lower trajectory but it will all depend on the response from the International Monetary Fund (IMF), European Central Bank (ECB) and the Greek government. Right now the general feeling is that the IMF / ECB are in a worse position than the Greeks. If they let the Greeks renegotiate a much more favorable deal, then other countries such as Portugal, Italy, Spain and a whole host of other tertiary countries will then ask the IMF / ECB “what about my deal”? Obviously this can’t happen but if this spirals out of control, the end result could be the disintegration of the Euro and the European Union.
If you were to force me to put the odds that the EU survives longer-term, I would say that it is about a 25% chance that it will be around 10 years from now. It is exceptionally difficult to take so many ethnic and traditional groups that have been operating independently for thousands if not tens of thousands of years and ask them to sacrifice for the benefit of a nebulous concept. In every economic situation (including socialism and Marxism) there will be winners and losers. If you decide to join the Euro and you benefit of course it’s a great deal and the concept of “we’re all Europeans” is easier to swallow. Yet if you are on the short end of the stick, like Greece and others are, then what? Do you think the populace is sitting around and saying “we’re all Europeans”? Maybe if the issues are short-term in nature it is plausible. However, if the problems are longer-term, then the end result would be exactly what we are seeing in Greece.
Additionally what few are realizing is that the EU was a fundamentally flawed concept. There are different philosophies on enforcing the collection of taxes, labor work rules, when pensions are earned and a whole host of other issues. For example, the early retirement age in Greece and Italy are 58 and 57, respectively. In Germany it's 65 and in Norway and the United Kingdom it's 62 and France is going from 62 to 65 between now and 2018. There are also variations among the other EU members as well.
Unlike the United States where the Social Security rules are relatively uniform and any variations are based on the year of your birth, the wide variations across many of the EU has created large entitlement payouts for workers that could be productive for 5 to 7 more years.
Many of the countries with fiscal problems generally have demographic, economic and entitlement issues plaguing them without the will to explore true reforms. Cultural and different work ethics make it difficult to tackle these issues but in the end changes will need to happen to right the ship.
If Greece defaults on their debt, exits the Euro or attempts to do something outside the bounds of what is expected, then an investor that has a long-term outlook should hold high quality equities. Those that are more concerned about significant losses should have established or be prepared to apply some risk management techniques to their equity portfolio.
If the portfolio also includes fixed income, an investor may want to direct a majority of their holdings in US Treasury securities, investment grade corporate / municipal bonds as well as other high quality fixed income products. Other riskier securities such as high yield corporate and emerging market debt for a portion of the portfolio may also be a consideration as long as the risk is understood.
What’s important to realize is that there is a chance that today’s selloff could mark a near-term low in the market and represented a great buying opportunity if you believe the worst was over. However, the potential for a significant downside move due to the uncertainty in Greece may warrant some caution and patience whereby you might want to hold off making some purchases.
If, on the other hand, you feel that you believe the worst is over and you want to deploy capital, it might be best to do so in a piecemeal fashion. This strategy will allow you to hedge your bets in the event your wrong even if that means your other purchases will be at higher prices.
Remember this situation is very fluid. Today it looks gloomy, but tomorrow the clouds could break and the sun may shine again over Greece. Having a game plan in mind no matter what direction you currently feel we are headed is the key and that's how I am approaching the situation. While this doesn't appear to be another 2000-2002, 2007-2009 or July-October 2011 scenario, my approach to being very flexible, willing to jump in at any moment yet wary was important during the darkest days of those periods.
If you have any questions or comments regarding this blog or any other thought, please contact me at firstname.lastname@example.org. Thanks for reading!!!
Source: Wikipedia through Forbes Magazine
Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.